The basics of Consumer Loans

Now it’s time to talk about another common way of borrowing money: loans.

Millions of people apply for loans to pay for high-priced items like cars, home improvements, and college education. Home mortgages are also a type of loan.

With a loan, you receive all the money the lender has approved for you in one lump sum. Then, to pay the lender back, you make equal monthly payments, called installments, for a fixed period of time, until the loan is paid off. This is called a long-term loan or an installment loan.

When you borrow money from a bank or other lender, keep in mind that there are costs involved. Lending money is a business. The lender — whether it’s a bank, a store, or a car dealer — makes money by charging you an extra amount over and above the amount of the loan itself. The amount of the loan is called the principal, and the extra amount they charge you to borrow the money is called interest.

How much interest you’ll pay for your loan depends on three main factors: First, it will depend on how much you’re borrowing: the principal. Second, your costs will depend on the interest rate. And the third factor affecting your interest payments is how long it will take you to pay the money back. This is known as the term of the loan.

And one more thing: in addition to the principal and the interest, the lender may also charge you fees for giving you the loan.

HOW Consumer LOANS WORK

Need money to pay for something big, like a car? You may need a consumer loan. Let’s look at how these loans work.

The lender may also charge you fees for giving you the loan. On top of repaying the principal, you’ll also have to pay the lender interest.

How much interest you’ll pay for your loan depends on three main factors: how much you’re borrowing, the interest rate, and how long it will take you to pay the money back, also called the term of the loan.

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COMPARE INTEREST RATES of consumer loans

Compare two sample consumer loans. Note how the interest rate affects the total amount of interest paid.

Interest rate comparison
Loan amount of $10,000 with a 5-year term

About the LoanLoan ALoan B
Interest rate5%15%
Monthly payment$188.77*$237.90*
Total interest over 5 years$1,236.92$4,271.08
* Note: the final month’s loan payment may vary from the regular monthly payment.

As for the interest rate, it’s important to shop around. Some lenders may give you a lower rate than others. In general, the shorter the term, the lower the total interest paid.

By getting a 5% interest rate vs. 15%, this borrower would save over $3,000 interest over five years!

Note: Always try to get a loan with the lowest interest rate you can. Remember: a strong credit score may help you qualify for a lower interest rate.

TRY IT OUT

Use the calculator below to figure out the details of a loan. This will help you get used to the term length and how much an interest rate on the loan can affect your monthly payment.

Cost of Loan
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co-signing a consumer loan

A co-signer (also known as a co-borrower) is someone who assumes equal liability with the primary borrower for the repayment of a loan. If you’re considering co-signing a loan, consider the following:

In some cases, co-signed loans that go into default, as many as three out of four co-signers are asked to repay the loan. If you’re asked to co-sign, you’re being asked to take a risk that a professional lender won’t take. Remember that if the borrower met the loan criteria, the lender wouldn’t require a co-signer.

In most states, if you co-sign and your friend or relative misses a payment, the lender can immediately collect from you. Also, the lender could decide to sue to collect. If they win the case, your wages and property may be taken.

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credit application checklist

Download Credit Application Checklist (PDF)

PREDATORY LENDING – YOU COULD BE AT RISK

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Who’s at higher risk of predatory lending? Anyone can be a victim of predatory lending, but for a variety of reasons some people are at especially high risk:

  • People with substantial equity in their homes and low or fixed incomes
  • Older adults with substantial equity in their homes
  • People with limited knowledge about finance
  • People with limited English skills
  • People with limited financial access and experience
  • Minorities and immigrants

For more information about predatory lending and learning about potential warning signs, visit the Selecting a Lender resource.

if the lender says no

There can be many reasons a loan may not be approved. There are 7 steps you can take to have the lender reconsider.

Reasons a loan may not be grantedSteps you can take to have the lender reconsider
1. Irregular employment or limited job history
2. Not enough income to repay the loan
3. Poor credit history (slow repayment of other loans)
4. Lack of credit history
5. Too short a time at residence
6. Insufficient down payment
7. Insufficient documentation
8. Application mistakes
9. Too much outstanding credit or loan debt
10. Too many (new) accounts or recently closed accounts		1. No prior credit? Apply for a credit card with a low limit and make small purchases / pay on time.
2. Find out if all sources of income were considered in evaluating your loan application.
3. Pay off some of your existing debt.
4. Find a reliable co-signer for the loan.
5. Offer to make a larger down payment if possible.
6. No credit history? Find out if things like rent payment or utility bills could be considered. These factors are called non-traditional forms of credit.
7. Look for errors in the information the credit bureau provided to the lender.